Bond markets generally have the last word in any major dispute with the Federal Reserve—or for that matter a spendthrift government—over how to interpret messaging on interest rates, deficits, and the broader safety of long-term cash.
What they’re saying on Thursday is worrying.
Benchmark 30-year Treasury bond yields, the market’s best representation of long-term inflation risks and expanding government deficits, are trading at the highest levels since 2007 following a wild Fed meeting that could test the credibility of new Chairman Kevin Warsh.
The paper was last marked at 5.239%, a stunning 14-basis-point leap from early Wednesday levels that followed the Fed’s decision to hold rates steady for a fifth consecutive meeting even as Warsh vowed to fight inflation and deliver price stability while uniting his colleagues on the rate-setting board to a singular message.
“The broader discussion to my ear over the course of the last days showed a lot of agreement on the hard questions,” Warsh said.
“Were there different leans on the answers? You bet there was. So could people come to different conclusions? Absolutely,” he added. “But my own judgment is this is a period of watchful thinking, not watchful waiting, and I think the score on that vote was unanimous.”
Bond markets, however, were in no mood to parse that difference, particularly with renewed tensions in the Gulf region driving global crude prices back toward $90 a barrel as inflation pressures linger.
The long bond moves, paired with a pullback in 2-year Treasury note yields as investors pared back bets on a Fed rate hike in September, created the biggest steepening of the yield curve, which tracks the difference between short and longer-dated yields, since the mid-1990s.
In the middle of the curve, benchmark 10-year notes were trading at 4.703%, just a tick or two away from their highest levels since 2023, as investors read Warsh’s hawkish tone but reacted to his inaction on rates as oil prices rise and inflation pressures increase.
“Once again, the Bond Vigilantes are pushing bond yields higher,” said Ed Yardeni, founder and head of Yardeni Research and the first person to coin the term in the early 1980s.
“In effect, they are saying that if the Fed won’t be vigilant about inflation, then they will have to maintain law and order in the economy,” he added. “Talking hawkish but not acting so reduces the Fed’s credibility.”
That’s a view that is now widely shared on Wall Street, and it’s likely to have a big impact on markets going forward.
A bond market that feels it is taking the lead on fighting inflation is likely to push long rates even higher, which will choke off funding to the consumer economy, stunting economic growth.
Stocks will suffer, as well, as higher rates challenge equity returns while subsequently weighing on present value calculations that determine price.
But even that assessment was difficult to reach following Wednesday’s press conference, and the subsequent selloff in markets that loped more than 1.7% from the tech-focused Nasdaq Composite and clipped more than 100 points from the S&P 500.
Krishna Guha, head of economics and central bank strategy at Evercore ISI, said the most striking feature of Warsh’s press event was his repeated references to the rise in bond yields, a framing that channels “old-school thinking that the bond market, not the Fed, ultimately sets rates.”
“But we came away confused as to whether Warsh is saying the bond market is telling us rates need to be higher over time, or whether the bond market is doing some tightening for the Fed,” he added.
For the moment at least, that void is being filled by a bond market that’s growing impatient with inflation while calculating the impact of rising debt and deficit levels. It’s also, perhaps, worried about the Fed chairman himself.
“Fairly or unfairly, memories of President Trump’s desire for lower rates and a dovish Fed chair will re-enter the conversation,” said Christian Hoffmann, head of fixed income at Thornburg Investment Management. “Credibility is much easier to lose than it is to gain. It is difficult to view [Wednesday’s] outcome as anything other than an own goal.”
The bond market has spoken.
Write to Martin Baccardax at martin.baccardax@barrons.com